The Blue Sky Laws and Corporate Policy

A number of recent studies debate the impact of investor protection law on corporate policy and performance. On one hand, many papers identify cross-country differences in firm characteristics and attribute these differences to variation in legal protection of investors from insider expropriation (which in turn is attributed to heterogeneity in countries’ legal origins). On the other hand, a number of studies find within-country evidence that changes in investor protection laws have little impact on corporate decisions.

I address this debate in a new working paper entitled The Impact of Investor Protection Law on Corporate Policy: Evidence from the Blue Sky Laws which I recently presented at the CELS 2009 4th Annual Conference on Empirical Legal Studies. More specifically, I exploit the staggered passage of state investor protection statutes (“blue sky laws”) in the U.S. in the early 20th century to estimate the effects of investor protection law on firm financing decisions and investment activity.

Regression estimates indicate that the introduction of investor protection law, keeping legal origin fixed, causes firms to pay out greater dividends, issue more equity, grow in size, and experience improvements in operating performance and market valuations. Additional analysis suggests that alternative hypotheses for the measured changes in corporate policy and performance – such as political economy considerations, changes in unobservable investment opportunities, and firm location decisions – have limited explanatory power.

Overall, the evidence is strongly supportive of theoretical models which predict that investor protection laws have a significant impact on firm financing and investment policy. The findings further suggest that proper design of legal institutions can have important implications for the functioning of capital markets.

The full paper is available here.